Increasing returns and perfect competitiion: The role of land

The classical inconsistency between increasing returns and perfect competition is studied. For example, if firms must pay a fixed cost of entry but then can produce using a constant returns to scale technology, they will generally operate at a loss, necessitating a government subsidy in order to attain an efficient allocation. Here we provide examples demonstrating that perfect competition and increasing returns can be consistent by extending the Alonso model to include production. The key is that producers use intervals of land, and the price they pay for land interior to the parcels can be adjusted to provide an implicit subsidy.